iShares MSCI Europe SRI ETF EUR Acc (LSE:IESE) - ETF price


ETF Report

iShares MSCI Europe SRI UCITS ETF EUR (Acc) IESE

AnalystReport

PortfolioConstruction

The MSCI Europe SRI Index is a part of the MSCI Europe & Middle East SRI Regional Index. The SRI index consists of around 120 names, weighted by market cap, that are identified as the top 25% of ESG rated companies within each sector. The MSCI SRI indexes are float-adjusted market-cap-weighted indexes consisting of stocks with the highest MSCI ESG Ratings making up 25% of the market cap in each sector and region of the parent indexes. The index also excludes securities of companies involved in controversial businesses. The MSCI SRI indexes are reviewed on an annual basis in May to coincide with the semiannual review of the parent index. The SRI indexes are also reviewed on a quarterly basis coinciding with the regular index reviews of the parent indexes. The changes are implemented at the end of February, August, and November. At quarterly reviews, changes are made in constituents: removing the ones that do not meet ESG eligibility criteria and adding the ones to those sectors with market cap coverage of less than 22.5%. The UK accounts for approximately 25%-30% of the index value, followed by France (15%-20%), Germany, and Switzerland (10%-15% each). Financial services is the index’s largest sector, with a 18%-22%, followed by healthcare (15%-20%), consumer cyclicals, and consumer defensive (10%-15% each). There is a level of portfolio concentration as the top 10 holdings account for around 40% of the total index value.

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Fees

With an ongoing charge of 0.30%, this ETF is not the the cheapest passive funds available, but it is significantly cheaper than most offerings in the category. Index funds should provide the returns of their benchmark, less fees. However, the fund has outperformed its benchmark since inception. But it can also be attributed to the fact that the fund is domiciled in Ireland and benefits from a lower dividend-withholding tax rate on French and Swedish stocks than the one used for index calculations. The fund’s annualised tracking error relative to its underlying index has been relatively low. Tracking error is a measure of how consistently a fund tracks its benchmark index. The closer the tracking error is to zero, the better or more efficient the fund is. Investors should also consider trading costs, including bid-ask spreads and brokerage fees, when buying and selling the ETF.

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FundConstruction

IShares uses physical optimised replication to replicate the performance of the MSCI Europe SRI Total Net Return Index. Instead of holding all the index’s constituents in the same weightings, the fund holds a sample basket of securities that reflects the return and risk characteristics of the index. While this replication method helps minimise trading costs, it can create tracking error. The fund uses futures for cash management purposes. This is standard practice and helps limit tracking error. The fund does not engage in securities lending.

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Suitability

IShares MSCI Europe SRI offers a low-cost and sensible approach to gain exposure to global equities with a strong focus on environmental, social, and governance factors. We have awarded it a Morningstar Rating of Silver.

The MSCI Europe SRI 5% Issuer Capped Index is a soundly constructed, well-diversified, and reasonably representative benchmark for the global developed-markets large- and mid-cap market. Active risk, as measured by tracking error versus the parent MSCI Europe Index, has been a moderate 1.8% from September 2007 to March 2019. This means that the fund’s risk/reward profile can be expected to closely approximate the MSCI Europe’s over the long term, although short-term performance can deviate.

The MSCI Europe Index has proved difficult to beat by active managers over time. Relative to category peers, funds tracking it have delivered above-average risk-adjusted performance in the trailing three-, five-, and 10-year periods.

Apart from focusing on the companies with sector-leading ESG characteristics, the SRI process also employs exclusionary processes, based on proprietary research. This is to ensure that the screening captures companies that violate international norms and principles, such as the United Nations Global Compact and ILO Core Convention; or are involved in controversial business activities such as tobacco, gambling, or controversial weapons.

By excluding around 75% of the market capitalisation, the index leans towards companies with better sustainability profiles. As a result, the fund has earned a 5-globe Morningstar Sustainability Rating and has had the highest exposure to sustainability factors compared with all peers in the Global category.

At 0.30%, this fund’s ongoing charge is average compared with plain-vanilla European equity ETFs but significantly cheaper than other global equity offerings.

All in all, we have a positive view of the strategy as defined by the index. The fund has a short track record, but we expect its portfolio will closely approximate the long-term return of the MSCI Europe Index, a strategy we regard highly.

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Fundamental View

Sustainable investing is a long-term approach that incorporates ESG factors into the investment process. Given the increasing recognition that sustainability issues can affect a company’s bottom line, it makes sense to consider ESG factors in a thorough investment process, especially one with a long-term perspective. This could also mean completely avoiding companies whose business activities are broadly considered as unethical.

The MSCI Europe SRI Index aims to reflect the performance of companies that meet stringent best-in-class criteria for managing their ESG risks and opportunities. The exclusions step relies on the MSCI’s ESG Controversies and ESG Business Involvement Screening proprietary processes. The former is designed to provide timely and consistent assessment on how well companies adhere to international norms and principles such as the UNGC and International Labour Organisation Core Conventions. The latter aims to identify the companies that are involved in certain controversial industries, including, but not limited to, controversial weapons, civilian firearms, nuclear weapons, tobacco, alcohol, and gambling.

As of this writing, the fund has a Morningstar Sustainability Rating of 5 globes. The rating is a measure of how well the companies held by a fund are managing their ESG risks and opportunities when compared with similar funds, including funds without explicit sustainability mandate

Historically, the SRI index has had an underweighting to UK stocks, while all other relative return contributors, such as sectors, countries, currencies, and factors were largely in line with the MSCI Europe Index. Evaluating the index’s active risk versus the parent benchmark is an important part of the due-diligence process as it ensures investors do not take any outsize risks.

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Alternatives

Socially conscious investors seeking exposure to the global developed markets have a handful of funds with high category-relative sustainability characteristics to choose from. Amundi IS MSCI Europe SRI ETF (0.18%) and BNPP E MSCI Europe SRI ETF (ongoing charge: 0.30%) are direct substitutes for this ETF.  

Apart from this, investors can choose X ESG MSCI Europe ETF (ongoing charge: 0.20%). By tracking the MSCI ESG Leaders Index, the fund has a similar ESG mandate but instead targets half of the European equity universe.

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